Improving public financial management

This article is a longer read containing some more in-depth reflections on the issues facing Governments in improving Public Financial Management to closer to commercial "best practice".

Introduction

Much has been written about the need to improve the quality of financial management in the public sector. There is a widespread perception that government is less effective at financial management when compared to industry – but relatively little of the discussion goes beyond a diagnosis of the problems to discussing effective solutions.  This article will examine some of the reasons why governments have not adopted similar financial management practise to business and what might be done to change practices in the public sector.

Some of the differences are a due to combination of cultural issues that set the remit for how finance people participate in the executive management of government departments. Certainly in many states, financial skills and experience are not as prominent in decision making or have the same representation at the top layers of the organisation – e.g. on departmental management boards.  In many countries there are also the consequences of a legacy of under-investment in financial training, talent and systems combined with lower levels of financial discipline and rigour in public financial management in comparison to businesses of equivalent scale. The disparity is especially stark when government is compared to publicly quoted businesses that are subject to scrutiny by the investment community.

Consequently in considering how to better undertake Public Financial Management in Central Government there are a number of aspects worth considering and comparing to the way in which publicly quoted companies operate:

  • Remit – what prominence does finance have in the organisation and what level of permission is it given to participate in executive management strategy formation and decision making? How are strategic financial management skills deployed for the activity of optimising overall financial resources to deliver organisational priorities and how does the organisation assess the effectiveness of this?
  • People – to what extent does the organisation have access to people with the necessary financial management, presence, influencing and communications skills who can make an effective and credible contribution to strategy and executive management. If insufficient how can these people be best acquired or developed?
  • Systems – to what extent are the financial management systems adequate for managing government departments either as individual entities or as a collective group? Is the financial position of government capable of being understood in a timely way with up to date information? Can cause and effect relationships be derived from financial management information in a way that allows for accurate prediction of outcomes from the deployment of resources?
  • Processes - are financial processes operated in an efficient, effective and rigorous way to ensure that all assets and liabilities are captured, appropriated valued and understood? Is risk effectively managed so that government departments, either individually or collectively, can be reasonably sure of their outgoings and maintain contingency plans to cope with a range of outcomes such that there is confidence that policies and plans can be delivered as expected?

In all of these areas there is a perception that the reality falls short of commercial best practice and that, as a consequence it can be concluded governments may not be making optimal use of the resources they raise from the taxpayer. At a time when across the world it is vital to maintain public confidence in government, these shortfalls need addressing.

Remit

While there has been progress with ensuring financial people have the correct remit in some jurisdictions government, for example following the Likierman and Keegan reforms in the UK – in most cases reform efforts have not gone far enough or been fully embedded. Many government  departments, in many countries continue to make senior financial appointments from policy ‘stream’ officials. Including appointments into posts where, in business, it would be unthinkable that they should not be occupied by anything other than trained, qualified financial professionals.  If policy officials feel they are being excluded from senior management roles, then the answer is surely to equip more of the people from that discipline with the necessary financial management skills and experience, before they are considered to be eligible to hold such posts.

Empowerment and roles

Ultimately financial managers can only make a positive impact on an organisation where they have been empowered and given the remit to do so. While some governments have genuinely brought their senior financial people into empowered executive management positions, in many government organisations, this has not been the case.  Not all organisations have their ‘finance director’ on the board and many constrain their role to focus more on aspects of reporting than participating in organisational strategy and planning.  Too often the finance director sits below board level and reports to a board member such as a ‘Director General of Resources’ who has a wider remit and is often from a policy discipline background.  Such approaches limit the ability of senior financial managers to use their skills effectively for the benefit of the organisation.  It also sends out a message that finance is not part of strategic planning or decision making.

There is also a “Catch-22” effect here – because financial people in many government departments (especially smaller ones) are not trained and developed with the expectation they will participate in strategic management, they sometimes conform to the expectations that they are not equipped to do so. In their selection and development, they have not been chosen for their influencing and communications skills or given the wider organisational experienced needed to give them credibility and breadth.  This can impact on remit or ‘organisational permissions’.  It is ultimately self-defeating for any organisation to exclude financial management expertise from any senior board or committee that involves the commitment of financial resources.  This needs to be part of the ‘constitution’ of all government bodies, that they ensure only personal with appropriate skills and experience hold posts with responsibility for financial management.

Skills for financial management roles

Ideally financial management skills should be incorporated into the early training of staff on accelerated development schemes who might at some stage of their careers be in a position to deploy and manage financial resources. Part of the remit for senior posts with financial management responsibilities should be demonstrable experience of the skills and aptitude for the role.

Giving some staff on accelerated development schemes the opportunity to train as professional accountants (as some governments do) is a good start. It helps to build a cadre of people with strong financial management skills who are likely to hold senior financial management roles in the future. Schemes of these nature usually only involve small numbers of people however, and financial management training of some sort needs to be made more prevalent. The answer may be a lower level qualification than a full professional qualification like Chartered Accountant.  Perhaps something like the ICAEW Business and Finance Professional (BFP) which is less time intensive to acquire and could be obtained by a larger contingent.

Top level financial management

For financial management to be truly effective, resources need to be co-ordinated, prioritised and managed to deliver overall policy outcomes and manage risk effectively at the overall top level of government. In many countries this falls to either one of the finance or economics ministries (or a combination of the two). However, once the overall budget is agreed, day to day financial management is very often conducted in the silos of individual departments. In the main, co-ordinating resources to deliver cross-cutting policy objectives – that might touch on multiple departments, such as improving health across the whole population or improving business investment are often hard to deliver in a co-ordinated way.

This is a tough issue to tackle, but ultimately there needs to be something like a group CFO function for Government as a whole, empowered to undertake strategic financial management and the prioritisation of resources to outcomes within budget periods. This could sit in the Ministry of Finance or elsewhere within the top executive, but wherever it sits, it has to have the power to deploy a level of discretionary financial resources in accordance with the overall priorities set by the leader of the government. This might be made sufficiently easier if a pool of resources for discretionary spending (as opposed to the running costs) was held centrally and not all resources were allocated to spending departments.

People

At present in many government departments financial management skills are under-represented in the leadership cadre and the contribution of finance teams is not given the prominence that it would in businesses of comparable scale and complexity.   This is to the detriment of government, as it leads to low levels of awareness of issues that may have a significant impact on resource consumption, unrealistic planning and sub-standard decision making.  All of which result in a less than optimal consumption of resources for the outcomes sought.

What is needed in government are more people at senior levels in executive management roles with a strong awareness of strategic financial management. Not only with good knowledge of financial management techniques that can be used and the standards that should be met, but also who know the right questions that need to be asked, how financial management systems should be organised and constructed to deliver the answers and the information requirements.  Experienced senior people will know the issues that need to be considered and how to derive useful insight.  They are focused on the future, not the past or present and skilled in asking the right questions to be able to plan resources to best position the organisation to deliver its plans.

Strategic financial management skills

The ideal is leaders within the organisation who use financial management techniques as a set of strategic tools to ensure that resources are best deployed to meet priorities, taking into account risk and the need to maintain a margin for error.   This needs people who can commission and utilise the necessary information on position, cause and effect relationships, risk and predictive analysis.  These skills enable financial leaders to understand how to maximise the use of capital invested by the organisation to deliver outputs, ensure that the organisation is sustainable and can meet the full range of liabilities as they fall due.

The difficulty in government is that while many of the people trained in the finance function disciplines, may have some of the technical know-how, insufficient numbers are coming through the system equipped with the wider interpersonal skills and experience needed to be effective at board level. Strategic financial management is a skill that requires many years of experience with a broad exposure to business operations to acquire. This experience is critical to allow senior finance managers to fully understand the wider operating environment, be credible at executive management levels and understand the realities of delivering organisational priorities.  Effective financial managers at the strategic level not only know how to create and maintain the systems and processes that can provide them with the information they need, they are skilled at contextualising it to support effective decision making. 

Obtaining strategic financial management skills

It is necessary to ensure these senior financial management skills are either created or brought into the organisation at a level where they can have a beneficial impact on decision making processes and the individuals discharging such roles have the presence, communication and influencing skills to be credible and authoritative.   All are a product of training and experience that is to some extent generic.  Because the discipline is not necessarily tied to the specifics of a particular organisation, such skills are transferrable between organisations and equally effective in the public sector, given remit and resources. 

All organisations tend to follow a mixture of either ‘making’ or ‘buying’ the skills required to raise standards of strategic financial management. There are advantages and disadvantages of both. 

Make:  

Pros

Grows talent and financial skills within the organisation and ensures that skilled finance people understand public sector values and ethos.

Less likely to cause cultural conflict than external hires

Cons

Can be captive to prevailing ‘group-think’

People who acquire market recognised skills with commercial value are more inclined to depart for higher value opportunities.

 

Buy:

Pros

brings ready-made strategic level financial management skills into the organisation

offers the benefit of commercial disciplines and knowledge of what success looks like from the perspective of other organisations

can inject pace and disproportionate impact if sufficient mandate with the potential to act as a powerful ‘change agent’.

Cons

usually expensive for high quality senior talent

can be cultural issues coming to terms with civil service and political priorities that lead to conflict and a failure to integrate into management structures.

many do not stay long enough for departments to capitalise fully on their experience due to frustration with the ‘system’.

Despite the draw-backs, used judiciously, hiring externally at senior level can bring powerful “change agents” into government. While they might spend a relatively short part of their careers in public service, this often means they can challenge current assumptions and have the moral courage to make lasting changes without being constrained by the fear of long term career consequences.  They can also be used to give home-grown talent a sense of what “good” looks like and of the standards and level of rigour necessary to deliver reliable insight and outcomes. 

While accelerated development schemes for finance people can provide a good long-term solution, governments really need to capitalise on the large pool of external financial management talent to improve their financial management performance in the short to medium term. At times government has really benefited from an injection of externally trained senior talent, however pay and recruitment-freezes can lead to a diminishing in the numbers of people with these skills.  Both as a consequence of government roles being less attractive and the exodus of people to better paid jobs back in the private sector.  What is needed is a more pragmatic approach to bringing in senior talent, if necessary on short term contracts (2-5 years would be a good range) taking into account remuneration and empowerment. 

Care needs to be taken however to select people who are a ‘good-fit’ for the role they are expected to play and there is a role for the head of the government finance profession in ensuring that senior financial appointments not only have the requisite financial skills, but also will fit in.

It is of course not sufficient to simply acquire the skills, they have to be supported with the authority and ability to deploy resources to build reliable systems and processes to discharge their roles effectively.

Systems

Governments often under-invest in financial management systems with predictable results. In many countries there is a patchwork of often incompatible and incoherent legacy systems (sometimes within a single department) many of which are either at the end of their lifecycle or out of support completely. Systems are often geared up for compliance and historic reporting with little evaluative or predictive power. They can be hard to interrogate flexibly or reconfigure to meet changing needs.

Often individual departments have modified off the shelf systems or built their own bespoke systems that are then difficult and expensive to support or modify, in some cases making them over-reliant on particular contractors who charge premium rates for their services. In the worst cases opportunities are missed because responsibility for system design and commissioning is given to staff without sufficient relevant expertise or domain knowledge. This can give rise to unrealistic expectations (which contractors charge a premium to meet), or in worst cases a failure to deliver systems of sufficient utility to meet the original objectives.  As much of the development activity is outsourced misunderstandings can and do arise as to system capabilities or functionality, resulting in missed opportunities and more limited functionality than is needed. 

Under-investment in systems is also often accompanied by lower levels of investment in the activities designed to utilise the capabilities and outputs of systems. Most government departments do not produce high quality management information, the task of producing it at a government wide level is practically impossible. This is often due to a lack of coherence in information standards and categories, configuration, operating segments and charts of account. Without a shared taxonomy it is not generally possible to interrogate systems for information regarding relationships between expenditure and activity, other than at the top level.

Without shared information standards and taxonomies government will not be well placed to take advantage of emerging analytical, automation and machine learning capabilities.   While modern systems increasingly can operate with unstructured data, dealing with poorly configured information does increase the complexity and development effort required to get utility from them.  If government is going to be able to take advantage of these technologies, it will need to improve its basic data management as well as making greater investment.

There are two particular problems that often need to be tackled in order to improve matters.

  • Establishing a coherent set of information and configuration standards for financial systems – these should be centrally mandated for all government departments to follow with agreed transition plans for all departments onto a common standard over a defined time period. While there may be some exceptions - this will form the basis of a more coherent set of financial systems and enable.  Setting up a central Systems Information Standards Office would be one way to create the standards supported by central funding dedicated to upgrading and conforming systems.
  • Maintaining financial systems expertise – the expertise required to establish standards and configuration for financial systems is in short supply in industry. Consequently, rather than disperse it amongst government departments, it could be recruited and concentrated in a centre of excellence – ideally within the Systems Information Standards Office, described above. This could in theory operate outside the normal constraints of the public service reward and grade frameworks and enable specialist expertise to be concentrated in an environment where the skills were understood and could be sustained.

Given the scale of government and the importance of financial management systems the costs of specialist staff would be justified by the improvement in overall financial systems performance and procurement from having an in-house expert team.   All departments would be required to take and act on the advice of this centre of excellence when procuring and configuring financial management systems. Such a centre of excellence could in theory cover its costs by recharging its costs to government departments using its services, but it might be more politic for the cost to be borne centrally.

There is no quick fix however. Both investment and enhanced standards are required, but it will not be a trivial task introducing them across organisations of the scale and complexity of most governments.  Quick wins might however be possible for work designed to ask specific questions.  Experience from the corporate world shows that faster incremental improvements can be made where systems are aligned and data cleansed to provide a small set of specific analysis.  This small set is then grown incrementally to encompass larger amounts of data and potential analysis.  The experience of business generally is that attempts to cleanse sufficient data ‘all at once’ to provide a wide range of analysis, invariably founder under the scale of effort required. 

Processes

Government departments do not often have the same focus on maintaining ‘the integrity of the books’ that commercial organisations have. Financial information is often stored in a multiplicity of systems, outside the main financial management system and the same rigour is not brought to bear in ensuring it is complete accurate and timely.  Reporting disciplines are often also weaker than in the commercial world. Even where accruals accounting has been adopted, often there is only an annual ‘hard close’ and typically a balance sheet produced once a year rather than on a monthly, or at least quarterly basis. Clearly there are some examples of excellent practice in public financial management – the Government of New Zealand produces a monthly balance sheet – but it is the exception.

Impact of lower levels of financial management discipline

The lack of strong financial management discipline means that information in financial systems is less reliable and sometimes contradictory to information held ‘off-system’ – this means there is not a generally agreed ‘single version of the truth’ which often undermines the ability of the top management team to control and divert resources to meet corporate level priorities. Audit takes longer or is weaker, and places far less reliance on testing the integrity of systems with far more substantive work having to be undertaken.  Lack of common approaches to data definitions and categories of expenditure mean that it is difficult to use data analytics without extensive work to ‘cleanse’ data.

Cross cutting functional disciplines are generally weaker than in businesses with less emphasis placed on compliance. There are rarely sanctions for individual managers who fail to maintain mandated corporate standards for financial management information and practices.  There is also little enforcement of information management discipline at all levels with no action taken against business areas that hold information ‘off-system’ or which fail to ensure that a single version of data exists in both corporate and local systems.

The lower levels of financial management discipline than seen in large, especially quoted, businesses also extends to regular management review of financial information and effective variance and exception reporting. The lack of good quality variance analysis and difficulty in examining the relationship of data to activity patterns means it is hard to identify cost drivers, make comparisons across the business and establish cause and effect relationships.  The forecasting system is rarely predictive and it is not unusual in many departments for the year-end figures and audit to contain surprises.

Risk management, while improving in many countries and given greater focus through the annual reporting process, is not always fully integral to senior management discussions throughout the year or evident in core planning processes. 

Commercial practice

The differences in the level of rigour between commercial best practice in maintaining financial management disciplines and those found in government departments ultimately comes down to the emphasis placed on these activities by senior management.   ‘Tone from the top’ is very important in setting expectations of behaviours and in ensuring that there are consequences for those who do not comply with corporate standards.

In a quoted company a failure to maintain corporate data standards would be a disciplinary event for a management team at any level within the business. Ultimately failure to maintain accurate and complete accounting records or to plan and forecast on a realistic basis inevitably leads to removal of those individuals responsible from management positions and in some cases, where this failure was to deliberately mislead auditors or investors, prosecution.

Employing people with strong financial management discipline into senior management roles definitely helps to improve working practices. However, for any system to be reliable and effective there have to be consequences for those who do not live up to the required standards.  This includes managers at all levels and the top management team.  A demonstrable and persistent failure to maintain complete, accurate and consistent records should be treated as grounds for disqualification from holding any management role that involves the responsibility for financial resources as it is in public companies. A new qualification to the auditor’s opinion in a set of accounts in industry, is grounds for removal of the financial team.  A similar discipline would probably need to be adopted in the public sector if the quality of information and reporting was to be significantly improved.

It is accepted that many managers in the public sector inherit situations where a combination of poor management practices, inadequate and outdated systems have led to material problems with the reliability and completeness of financial records. On taking up responsibility for a post where such weaknesses are identified there needs to be an allowance for an action plan to be formulated and to take effect.  This should form part of the appointment conditions to the post in question however with performance review based on progress made in tackling the shortfalls.

Conclusion

A multi-strand approach encompassing remit, people, skills and processes will be need to significantly improve financial management performance to commercial best practice.   This will require a cultural shift, up-skilling of personal and investment over many years to achieve similar levels of performance.  The difference between government and business is that in the latter, the commercial case for making such improvements is usually compelling.  The financial management performance of commercial organisations, their ability to understand their position and effectively manage their resources, are critical to staying in business. 

Government does not have the same immediate threat of insolvency or the need to maintain and grow profits in a competitive environment. Partly as a consequence, it also does not have good measures of what current sub-standard practices cost it in terms of under-utilised assets, wasted resources arising from sub-optimal decision making or policy making based on inaccurate and incomplete data. That is not to say no organisation has a view - the State Auditors of many countries might well have the data to attempt this calculation.

Making the case for a stronger remit for finance and enhanced investment in people, systems and process is likely to start with an understanding of the unreported costs of the current system. While this might not be a comfortable exercise for the executive management in government, the prize of making the resources go further, not having to ask tax-payers for more money and improving the sustainability of the public finances, is surely worth it.

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